Lately, a con­ver­gence of events — grad­u­a­tion sea­son, impend­ing expi­ra­tion of a sub­sidy on stu­dent loans, and an elec­tion year — have led to a broader dis­cus­sion about the over­all econ­omy of higher edu­ca­tion. In par­tic­u­lar, some have sug­gested that we have an “edu­ca­tion bub­ble”. How accu­rate is this sug­ges­tion? And, if it is, what are the poten­tial impacts of it bursting?

To answer this, we should start by exam­in­ing the mean­ing of an eco­nomic bub­ble. His­tor­i­cally, eco­nomic bub­bles were referred to as “booms”, and their pop­ping as “busts”. Only the ter­mi­nol­ogy has changed.

Booms are caused when credit grows rapidly in a par­tic­u­lar mar­ket, lead­ing to ris­ing prices, and over­ex­pan­sion. Even­tu­ally this leads to a point where the return on invest­ment is no longer assured, which causes the credit to quickly dry up, and the mar­ket to then col­lapse (the “bust”). The credit for the boom can come from many dif­fer­ent sources, but typ­i­cally the late stages of the boom are funded by pri­vate creditors.

We saw this hap­pen with Inter­net com­pa­nies in the late 1990s, as their stocks sky­rock­eted from a tremen­dous influx of pri­vate invest­ments. We saw it hap­pen more recently with real estate, as home prices sky­rock­eted from a tremen­dous influx of pri­vate invest­ments in credit default swap–backed col­lat­er­al­ized debt oblig­a­tions, which funded the mort­gages that funded the real estate pur­chases. In both of these cases, the credit dried up when spec­u­la­tors were no longer able to turn prof­its by reselling the invest­ment property.

What about higher edu­ca­tion? (more…)